Cisco Gives Convergence a Push

Scientific-Atlanta deal provides video piece of “quadruple play”

Since cable systems are starting to look more and more like computer networks, Cisco wants a bigger piece of the action. Last week, the giant networking company showed how badly it wants to play, ponying up nearly $7 billion to do it.

Cisco on Friday cut a deal to buy Scientific-Atlanta (S-A), one of the largest technology suppliers to the cable industry. S-A shareholders will collect $6.9 billion, or $43 per share, from San Jose, Calif.-based Cisco, which has long been a major player in computer networking, helping telecom and general businesses keep their PCs, servers and mainframes talking to each other.

Two forces drew Cisco into the cable-TV industry. First, the cable set-top is increasingly resembling a PC, morphing from a relatively dumb box used to change channels into small computers that integrate video-on-demand (VOD), hard drives for digital video recording, and even DVD burners.

At the same time, TV is pushing its way onto computer networks. Disney CEO Bob Iger rocked the industry when he allowed video iPod users to start downloading episodes of ABC's best product, Desperate Housewives and Lost. Telcos Verizon and SBC are building video systems based on the same protocols as the Internet. Just last week, NBC Universal agreed to sell Universal movies over World Media's peer-to-peer online service, and Warner Bros. teamed with AOL to offer old TV series.

Network executives see Internet video deals as a potential threat to their advertising business. Cable operators fret that consumers will be able to dump video service and watch HBO online.

Cisco executives see the world through a telecom prism. Delivering fat, live video through computer networks is a much bigger job than helping companies transmit e-mail, Web pages and phone traffic.

When it comes to building networks, says Cisco Senior VP Mike Volpi, “the bandwidth-dominant application—which clearly is video—often is the one that dictates how networks are built over the long term.” And Cisco wants to be there not just with the right gear but with the expertise of handling the massive amounts of digital video cable that operators pump through their systems each moment. S-A offers the kind of expertise Cisco needs.

S-A has for decades been one of the two manufacturers dominating the market for cable equipment. Set-top boxes are the most visible part of that game, accounting for 60% of S-A's revenues.

The less visible part of Scientific-Atlanta's business—about 40% of sales—is the cable system itself, including the headend that takes video from satellites, and all the gear necessary for Internet traffic and phone calls.

In some ways, S-A is the opposite of Cisco. A cable system is a relatively closed network. Encryption has for years been a highly proprietary technology. Outside companies generally have difficulty designing new equipment that works on existing cable systems. That is why S-A executives take pride in that their expertise in “system integration”.

But that's changing. Encryption systems that keep people from stealing cable are becoming more open. Operators are switching to the same Internet Protocol used for Web traffic, phone calls and, more important, telephone companies' own new video systems.

Cable is a promising but relatively small market for Cisco. The networking company generates $24 billion in annual sales. S-A generates about $1.3 billion. Cable operators spend about $10 billion on equipment each year. That's a fraction of the multibillion-dollar market for conventional computer-networking gear. Cisco CEO John Chambers notes that a single telephone company spends more each year than the entire cable industry.

So why is Cisco stepping up for this deal? Partly because it wants to be a player in every layer of the communications business. Chambers notes that the company already supplies operators with gear for Internet and telephone service, but not much for video.

“Video is emerging as a key element in the service provider 'quadruple-play' bundle encompassing consumer entertainment, communications and online services In fact, video may be the most critical element in this bundle for ensuring consumer differentiation and loyalty, or stickiness if you will, to service providers. The opportunity for Cisco is to dramatically reduce the complexity of converging data, voice, and video over IP in both a fixed and mobile environment, which is at the core of our expertise.”

Ken Kerschbaumer contributed to this report

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